UPDATE 1-China ups Treasury buys but foreign demand fades

Mon Apr 16, 2012 7:20pm IST

By Steven C. Johnson

NEW YORK, April 16 (Reuters) - China boosted purchases of U.S. government debt for a second straight month in February, U.S. Treasury data showed on Monday, but foreign demand for long-term U.S. assets weakened.

Even China's buying was concentrated in short-dated assets such as bills, analysts said, a possible sign China's willingness to extend cheap loans to the U.S. government is fading.

"We're still concerned about China because it's clear they are not investing in U.S. long-term Treasuries at the pace they used to," said Michael Woolfolk, senior strategist at BNY Mellon in New York.

China, the largest foreign U.S. creditor, increased Treasury holdings by $12.7 billion to $1.179 trillion, the second straight monthly increase after five months of net selling.

Over the weekend, China widened the yuan's trading band against the dollar, suggesting authorities feel the economy is healthy enough to withstand a stronger currency. That would reduce the central bank's need to hold down the yuan's value by buying Treasuries.

China's foreign exchange reserves total more than $3 trillion, with more than two-thirds thought to be in dollars.

"China can't just stop buying Treasuries. That would hurt them given their overall position," said Douglas Borthwick, managing director of Faros Trading in Stamford, Connecticut. "But they can just roll over their positions in the short end rather than buy long-term securities."

Other foreign investors mimicked that behavior in February. Including short-dated assets such as bills, foreigners snapped up $107.7 billion from a downwardly revised $3.1 billion inflow for January.

But the United States attracted a net long-term capital inflow of just $10.1 billion in February after drawing an upwardly revised $102.4 billion in the first month of 2012.

Woolfolk said reduced demand for long-term Treasuries could put pressure on the Federal Reserve as it tries to support the economy and the troubled housing market by keeping long-term borrowing costs low.

The benchmark 10-year Treasury yield was trading at 1.98 percent on Monday but briefly spiked to 2.40 percent last month, which Woolfolk called "alarming" for the market and the Fed.

Japan, the second-largest foreign holder of Treasuries, boosted holdings to a record $1.096 trillion.

Overall, foreigners bought a net $15.4 billion in U.S. government debt in February, down from $83.9 billion the prior month.

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